Sale of Real Estate in Mexico

by David K. Armstrong

U.S. citizens buying or selling real estate in Mexico face concepts not normally seen in the United States, including three separate types of taxes - income taxes, real estate acquisition taxes, and possibly IVA taxes (value added taxes), and other potentially vague terms.

TAXES

Income Tax

The proceeds from the sale of real estate in Mexico are considered Mexican source income. If a non-Mexican individual or company is the seller, the sale of Mexican real estate will be subject to a 20% capital gains tax on the gross proceeds from the sale without any deduction. However, taxpayers with a Mexican representative may elect net basis taxation at 30%. Under net basis taxation, gain is calculated by deducting from the gross proceeds (1) the original cost of acquisition, (2) the cost of improvements, (3) notarial expenses and other costs of sale, including appraisal costs, and (4) commissions. The original cost is separated between land cost and cost of buildings, with at least 20% allocated to land. The cost of the buildings and any other improvements is then decreased at 3% per annum between the date of acquisition and date of sale, but the cost is not decreased below 20% of the original amount. On the other hand, the cost of the land is increased based on changes in the National Consumer Price Index.

The tax code considers that a transfer of property has occurred when a trust is created, if the grantor designates or agrees to designate a beneficiary different from such grantor and does not reserve the right to repurchase the property placed in trust, or when the beneficiary loses the right to reacquire the property from the trustee. In addition, when the beneficiary assigns rights granted or gives instructions to the trustee to transfer the property to a third party, a transfer of property is considered to take place upon issuance of said instructions or upon the assignment of rights. Therefore, when a non-Mexican acquires beneficiary rights through a trust, and then sells or assigns them, the non-Mexican will be subject to the payment of income tax in the above-mentioned terms.

Income generated by non-Mexican landlords on real estate in Mexico is subject to a 21% income tax on gross rental receipts. The lessee shall withhold the tax, and pay it to the tax authorities. If the real property is held through a fideicomiso (bank trust), the trustee is required to make the withholding.

If a non-Mexican is the purchaser of real property, the Mexican tax authority may make an appraisal (avalúo) of the property, and, if the value of the appraisal is greater than the purchase price by more than 10%, the purchaser will be required to pay a 20% tax on the difference between the two amounts. The taxpayer shall pay this tax within 15 days following notification from the tax authority.

Real Estate Acquisition Tax

Individuals or companies purchasing real estate, consisting of land, or land and its improvements in Mexico, are subject to the payment of a real estate acquisition tax calculated at the rate of 2% of the value of the property (the rate may vary from state to state from 2% to 3.3%). All purchasers of real property, irrespective of the nature of their operations, must pay this tax whether the acquisition is carried out through a purchase and sale agreement, donation, trust, assignment, mergers of companies, split-off, or payment in kind.

Typically, there will also be a 1% notario fee on any transfer of property. The value of the real property is considered the highest value of (I) the value determined in the acquisition, (ii) the value used for annual property tax purposes, (iii) the value established by the tax authorities, or (iv) the value determined by independent valuation.

Value Added Tax (Impuesto de Valor Agregado)

IVA tax is paid by the purchaser of buildings and other structures at the rate of 15% of the purchase price.

No IVA tax is due on the sale of land used for any purpose and structures used for residential purposes. If only part of the construction is used for this purpose, IVA tax will not be required to be paid on such part.

OTHER NEW CONCEPTS

Notario Público

In Mexico, the office of a notary public is far different from the U.S. notary. A Mexican "notario" is an attorney who, after passing rigorous examinations, is commissioned by the government as a public notary. A notario holds high office for life, unless he or she is removed for cause. The notario fulfills a public function delegated by the government. Although licensed as an attorney, the notario is not in a position to provide either of the parties with legal advice. The notario drafts documents, verifies the facts therein, and records the documents with the Public Registry. The notario’s fee generally ranges between 1% and 2% of the value of the asset and the total amount that the buyer pays to the notario (including taxes) is usually approximately 6% of the price.

The role of the notario in real estate transactions is as follows:

(i) The buyer normally hires the notario who will serve as an independent and neutral counsel to both the buyer and seller or lender, as to their respective rights and obligations, and ensures that they have taken all necessary steps to conclude a valid contract according to the mutual instructions of the parties. The notario’s responsibilities include collecting and reviewing the sales contract, property tax and water payment receipts; ordering a bank appraisal; freezing the property’s file at the local public registry (no documents may be recorded in a property’s file during three consecutive thirty-day periods); reviewing the property’s file to verify the legal ownership and search for liens, encumbrances or anything that could affect the title (as the majority of public registries are not automated, this procedure can take from 60 to 90 days); requesting the public registry to issue a "Certificado de Libertad de Graveneres" (Certificate of Freedom from Liens and Encumbrances); and performing the closing at this office where the notario handles the transfer of the deed, tax withholding on the underlying real estate transaction, and the recording of the documents at the public registry.

(ii) Should a mistake occur, little recourse against a notario is available. Malpractice insurance is not a requirement for notarios, nor is it available in Mexico. Although the notario is required to obtain a bond to practice, there is no limitation on the amount of land he may convey, obligate or encumber.

(iii) To ensure accuracy, it is not uncommon for a purchaser of real estate to hire an attorney to verify the findings of the notario.

Title Insurance

Title insurance is not typically available in Mexico. Instead, Mexicans usually rely upon a notario’s title search and/or the opinion of a Mexican attorney. Certain U.S. companies, however, are now beginning to offer title insurance on Mexican real estate interests to non-Mexican investors and lender. These title policies will typically have additional coverage limitations that are not common in the United States, and the cost also will be greater. An application fee of at least $3,000 is typically required up front for the lawyer’s title search and for copies of the documents that are necessary for the title company to issue a title commitment. A survey will also be required and will cost at least $750. The title search and survey requirements usually lengthen the turnaround time for the issuance of a commitment from what we expect in the United States, but obtaining such a commitment is a valuable part of a buyer’s due diligence. Under these policies of title insurance, the obligations of the title insurer will be decided under U.S. laws and in the United States. Otherwise, the only defense or recourse against title defects is to litigate in Mexico.

The policy premium is due at the closing. For an owner’s policy, the average premium cost is approximately $8,750 per million dollars of coverage (although we have worked with reputable U.S. title companies that only charge $5,000 per million dollars of coverage). For an additional lender’s policy on the same transaction, the premium will be approximately $300 per million dollars of coverage. By comparison, in the United States, the average premium for a $1 million owner’s ALTA policy is between $2,800 and $4,000.

For additional information, please contact David K. Armstrong via telephone at 801.237.1981, via fax at 801.237.1950, or via e-mail/Internet at armstrd@swlaw.com.